BLACK - SCHOLES

Black - Scholes Option Pricing Model



Black - Scholes Option Pricing Model

Introduction

Black - Scholes Option Pricing Model is the model used for calculating the premium of an option. This type of option pricing model was introduced in the year 1973 and was published in the “Journal of the Political Economy”. Black - Scholes Option Pricing Model was developed with the help of three economists that were Robert Merton, Fischer Black and Myron Scholes. This model becomes the world's most used and important pricing option in the today era. In 1997, Nobel Prize award was awarded to the Scholes and Merton while the black was passed away. The Nobel Prize was given to them because of the new techniques developed by them in the area of derivatives (Borak et. al, 2013, Pp. 59-78).

Black - Scholes Option Pricing Model is the model which is used to calculate the price of the European call option. This type of option pricing model does not consider the effects of dividend that was paid during the life of the option but only considers the future dividend value. The model is calculated through the use of the ex-dividend date value while calculated the value of the stock. For calculating the Black - Scholes Option Pricing Model, certain assumptions are taking into consideration. First, the option should be European option so therefore only exercise at the end of the expiration. Second, no dividend should be paid in the whole life of the option. Third, Black - Scholes Option Pricing Model requires the efficient market that means that the market movement should not be predicted (Borak et. al, 2013, Pp. 59-78).

Fourth, risk free rate and the volatility of the option should be well known and constant throughout the life. Fifth, Black - Scholes Option Pricing Model should follow the lognormal distribution which means that the return of the options should be normally distributed. The present study is all about the Black - Scholes Option Pricing Model, the strength and weakness of the Black - Scholes Option Pricing Model and change in the value of the Black - Scholes Option Pricing Model (Borak et. al, 2013, Pp. 59-78).

Discussion

Black - Scholes Option Pricing Model

The formula use for Black - Scholes Option Pricing Model takes the various variables into consideration. These variables and determinants of the Black - Scholes Option Pricing Model are risk free interest rate, strike price of the options, implied volatility, time of the option and the current price of the option. The formula of the Black - Scholes Option Pricing Model is divided into two parts. First part include SN(d1) and the second part is the N(d2)Ke^(-rt). The Black-Scholes Option Pricing Model was used to exercise at the expiration time of the option therefore it is called European Option (Kreps, Pp. 1982, 203-232).

Strengths of the Black-Scholes Option Pricing Model

Black-Scholes option pricing model is the pricing model that is used in the financial market in order to note the financial assets and derivatives rules in the finance ...